Credit rating agency AM Best is maintaining a stable outlook for the global reinsurance sector in 2008, though it has concerns that the price deterioration of soft market conditions and strong competition could affect operating performance.

Bermuda has a massive reinsurance industry, with a capital value of $129 billion by the end of the third quarter of 2007, according to reinsurance brokerage Guy Carpenter.

Best said its stable outlook for the sector reflected generally strong balance sheets, continued improvements in enterprise risk management (ERM) and general earnings momentum through 2007.

"The global reinsurance sector has benefited from two years of moderate catastrophe losses and solid operating earnings," Best stated yesterday. "The capitalisation of the sector and the majority of its participants are currently healthy when just a few years back, many reinsurers were struggling to find capital.

"In large part, improved loss reserve adequacy is apparent for several companies benefiting from the hard market years and intensified risk management strategies. Though still nagging a handful of companies, legacy issues from soft market years continue to subside.

"Nonetheless, with rate declines in both property and casualty business lines, it is unlikely that current reserving levels can be maintained or be relied upon to boost earnings in outward years."

Depending on catastrophe activity, Best expects a profitable year for reinsurers, though with moderate margins and the agency expects the soft market to persist for some time.

"Barring a mega-catastrophe that removes enormous amounts of industry surplus from the market, AM Best does not expect an improvement in pricing levels for some time," Best stated. "The success factors for navigating these rough waters are for reinsurers to maintain underwriting controls and standards to determine pricing adequacy and maintain discipline in a challenging environment. History indicates these are not easy tasks to accomplish."

Capital management would be a "critical factor" in managing the market cycle, Best said.

"While share repurchase programmes and increased dividends have given a sizeable portion of accumulated earnings back to stakeholders, there is considerable pressure on reinsurers to achieve targeted return on equity," Best stated.

"Many carriers since have established diversified operating platforms, while newer formations have looked to build underlying capabilities to manage the cycle and deploy capital. AM Best expects that the merger and acquisition buzz will continue through 2008 with the possibility of more deals."

Best said it was no longer easy for insurance companies to ignore solutions from capital markets as an alternative to traditional reinsurance.

"After paying high reinsurance costs over many years, financially improved cedants are more sophisticated and are assessing how much reinsurance coverage to buy in more economic terms," Best stated.

"Although the reinsurance sector's capital position is strong, recent history indicates the pain that soft casualty markets can inflict on required capital year after year, and how large-scale catastrophes can remove massive amounts of capital from the market in the blink of an eye.

"AM Best believes that 2008 will be an important year for the global reinsurance industry, as it can influence the direction of the market for years to come."